Exam 1 Finance Test Review Questions
You have just graduated college at age 22 and set a goal to save $50,000 by age 26. You think it's reasonable that you will save $10,000 in the first two years and $15,000 in the third year. Assume that you can earn interest at 6% APR and you currently have no savings. How much will you have to save in the fourth year in order to reach your goal?
$10,953.84
When Pikachu started his freshman year in college four years ago, he received a $500 scholarship. The scholarship also paid him $300 at the start of his sophomore year (2nd year), $200 at the start of his junior year (3rd year), and $100 at the start of his senior year (4th year). He also received an extra amount upon graduating today, which is at the end of his senior year (4th year). He saved all the money in an account at 6% interest and has a total of $1,444 in his account today. How much money did he receive today at graduation?
$124.74
Jimmy's parents opens an account with UBS with $3000 on his 6th birthday The account earns 5%. They deposit $3000 every year up to and including his 10th birthday. If the account's interest rate remains at 5%, what is Jimmy's account balance when he goes off to college on his 18th birthday? A) $24,492 B) $18,835 C) $53,139 D) $16,577 E) $21, 157
$24,492
Your parents want to set up a college fund for your younger brother. They expect the first tuition amount to be $25,000, which will be due in 11 years. They expect the tuition to grow at 4% per year over the following three years. (There will be 4 annual tuition payments.) The college fund will earn 8% per year. If your parent wants to completely fund the college fund right now, then how much should they put into the fund today?
$40,563.89
Jennifer owns shares in Noom Corporation. Noom Corporation has earnings before taxes of $500,000. They distribute all earnings as dividends. If the personal tax rate on dividends is 15%, corporate tax rate is 25%, and the payroll tax rate is 7.5%, then what is the effective tax rate on her share of corporate earnings? A) 36.25% B) 40.00% C) 47.50% D) 32.25% E) 22.50%
A
On the day Horatio graduated college, he placed all of his savings of $17,000 into an account that earned 8% per year. Many years after graduating, he moved his savings into a risky venture, the world's first turtle circus. 12 years after he started the circus, he sold it for $250,000. From the day he started the circus to the sale, he earned a 15% annual return on this investment. How many years must have passed between graduating college and starting in the turtle circus?
13.14 years
Edward Saint John would like to have $1,000,000 in his retirement account 1 year from today. He currently has $700,000 saved in the account. He will start saving from next month and will grow his savings by 1.5% every month over the next 1 year. His account earns 2.5% monthly interest, how much should he save next month to reach his goal?
3,924
Choose the statement that is TRUE concerning the financial manager of a corporation. A) Compensating financial managers with stock or stock-linked securities induces them to act in shareholders' interests. B) The goal of the financial manager should be to maximize earnings per share. C) Compensating financial managers with cash salaries and cash bonuses induce them to act in shareholders' interests. D) The goal of the financial manager should be to maximize revenues. E) If financial managers maximize shareholder wealth, then the corporation's employees and the environment would necessarily be exploited and harmed.
A
Genesis Group is a C-Corporation with $200,000,000 in pre-tax profits. It pays 30% of net income as dividends. The personal wage income tax rate is 40%, and the personal dividend income tax rate is 15%. It has 10,000,000 shares outstanding. What will happen to the after-tax income per share after the corporate tax rate falls from 35% to 20%? A) $0.77 increase B) $0.09 increase C) $0.30 increase D) $0.39 increase E) $0.54 increase
A
You would like to have $500,000 in your retirement account 35 years from today. You will make your first contribution of $4000 in one year and increase your annual contribution by 7% for 16 years. Your account's rate of return is 13%. On the date of the 16th contribution, you plan on transferring that money into a safe bank account. What is the minimum interest rate you would need to reach your goal? Round to the nearest hundredth. A) 3.21% B) 1.73% C) 7.57% D) 4.20% E) 3.82%
A
You plan to retire 40 years from today. You want to have enough in your retirement account on the day you retire to allow you to withdraw $250,000 per year for 30 years. The first withdrawal will be one year after the day you retire. You can invest your money at 8% per year, and you will increase how much you will save by 1% per year during your working years. The first deposit into your retirement savings account will be exactly one year from today. How much does that first deposit have to be?
Answer: D Explanation: A) D) Target Savings at Retirement: PV = 250,000/0.08(1-1.08^30) = 2,814,445.8358 (N=30 I=8 PMT=250000 FV=0 CPT PV = 2,814,445.8358 FV of Growing Annuity = 2,814,445.8358 = PMT1/(0.08-0.01)(1.08^40-1.01^40) PMT1 = 2,814,445.8358*(0.08-0.01)/(1.08^40-1.01^40) = $9,735.84
Today is your birthday, and you decide to start saving for your college education. You will begin college on your 18th birthday and 6will need $4,000 per year at the end of each year of the following 4 years. You will make a deposit 1 year from today in an account paying 12% annually and continue to make an identical deposit each year up to and including the year you begin college. If a deposit amount of $2,542.05 will allow you to reach your goal, what birthday are you celebrating today? a. 13 b. 14 c. 15 d. 16 e. 17
B
Which of the following is TRUE about valuing cash flow streams? A) The present value of a stream of cash flows can be calculated by taking the product of all the present values of each individual cash flow in the stream. B) To calculate the present value of a future cash flow we must discount it. C) Time value of money equations are only useful if negative cash flows occur at the same time as positive cash flows. D) Cash flows from annuities last forever. E) Only values at different points in time can be compared and/or combined.
B
You are establishing a charitable trust fund that will make a single donation every year to charity. The first donation of $10,000 will be made in one year. The amount of every subsequent donation will increase by 2%. If this trust fund earns 5.5% interest annually, how much money will it cost you today to establish the fund? A) $281,326.02 B) $285,714.29 C) $313,268.41 D) $162,851.84 E) $229,039.57
B
Your firm can borrow from its bank for one month. The loan will have to be "rolled over" at the end of the month, but you are sure the rollover will be allowed. The APR is 14%, monthly compounding. Alternatively, your firm can borrow from an insurance company at an APR that would involve quarterly compounding. What APR with quarterly compounding would be equivalent to the rate charged by the bank? a. 12.44% b. 14.16% c. 13.55% d. 13.12% e. 12.88%
B
3) Which of these statements is FALSE? A) An inverted yield curve indicates interest rates are expected to fall B) A normal yield is upward sloping C) An inverted yield curve typically follows a recession D) A steep yield curve indicates interest rates are expected to rise E) A steep yield curve typically follows a recession
C
CAVA will pay $5,000 per year, starting four years from now, to the Smith School of Business for cash prizes and competitions. The agreement states that these payments will last forever. What is the present value of these promised payments if the discount rate is 5%? A) $100,000 B) $95,238.10 C) $86,383.76 D) $92,714.25 E) $82,270.25
C
Edison Electric, a power company, is issuing a new class of preferred stock that will pay a dividend of $2.50 per quarter (i.e., it will pay $2.50 per quarter forever). Another similar power company, Franklin Utilities, has a preferred stock has a market value of $75, and pays a dividend of $4.00 every six months. What should be the price of Edison Electric's preferred share if investors require the same effective annual rate as on Franklin Utilities' preferred share?A) $46.88 B) $93.75 C) $94.98 D) $91.31 E) $10.00
C
Harold is looking to build an addition onto his house, but he will need to finance the project. He has two options:1. A bank offers a loan for one year at 13% APR compounded monthly.2. The contractor will accept payment in equal payments of 3.3% per quarter over the course of one year.Which option presents the lower rate and what is its EAR? A) Bank loan: EAR 13.01% B) They are the same: EAR 13.00% C) Bank loan: EAR 13.80% D) Contractor loan: EAR 13.20% E) Contractor loan: EAR 13.87%
C
Terp's Corporation has a profit margin of 5%, an asset turnover of 1.8 and a debt-to-equity ratio of 2.0. Ruby's Corporation has a profit margin of 6%, an asset turnover of 2.0 and a debt-to-equity ratio of 1.0. What new asset turnover should Ruby's Corporation target be so that it has the same ROE as Terp's Corporation? A) 2.50 B) 2.0 C) 2.25 D) 1.5 E) 1.75
C
Wallace Loh is the owner of Terrapin Aluminum Company and is considering organizing as a C Corp or S Corp based solely on taxes. All corporate net income will be paid out as dividends if he structures as a C Corp. Pre-tax corporate earnings will be $7 per share. The corporate tax rate is 27%. The personal tax on dividend income is 21%. The personal tax rate on ordinary income will be 37%. Which type of corporation would maximize Wallace's after tax income per share? What would his income per share be? A) He should structure as a C Corp and earn $4.41 per share B) He should structure as a C Corp and earn $4.04 per share C) He should structure as an S Corp and earn $4.41 per share D) He should structure as an S Corp and earn $2.59 per share E) He should structure as a C Corp and earn $1.49 per share
C
Which of the following is an example of a primary market transaction? A) A floor broker of the New York Stock Exchange submits a limit order written on a slip of blue, red, or yellow paper. B) A stock dealer quotes an ask price for Ezekiel Enterprises on the NASDAQ, which a buyer eventually accepts. C) Jeremiah Jewelers raises $10 million from issuing bonds through an investment bank. D) A GM-owned dealership sells a Cadillac in Germantown. E) One day after the company went public, Ruth buys 10 shares of its stock on the New York Stock Exchange.
C
Which of the following is the best example of the managerial agency problem? A) The CEO of a large company compensates employees with bonuses that are comprised of shares in the company. B) Acting in shareholder's best interests, the manager takes risks that the bondholders prefer she not take. C) A manager avoids making risky decisions that would increase the stock price because her salary is based solely on the most recent year's sales. D) The manager of a major firm's 401k is comprised solely of shares in that firm. E) All managers make decisions with the goal of maximizing shareholder wealth.
C
Which of the following statements is true about the yield curve? A) The yield curve displays how the yield to maturity of the same bond changes over time up until the maturity date. B) The yield curve is parabolic, crossing the x-axis twice, where the x-axis is yield to maturity and the y-axis is a bond's price. C) The yield curve displays the yields of different bonds with different maturities plotted against their maturities. D) A downward sloping yield curve is thought to be a leading economic indicator of economic expansion and is its typical shape of the yield curve. E) The yield curve displays the price of the same bond over time up until the maturity date.
C
Which of the following statements is true? I. Given the same number of periods, discount rate, and payment, annuities due have a greater present value than ordinary annuities. II. Given the same discount rate, first payment, and growth rate, growing annuities have a higher present value than growing perpetuities. III. Given the same discount rate and payment, perpetuities have a higher present value than annuities. A) III only B) I and II C) I and III D) II and III E) I, II, and III
C
You have a loan of $12,000 and will repay the loan with monthly payments over 6 years at 6.5% interest compounded monthly. How much pays off the principal in the first month? A) $210.50 B) $201.72 C) $136.72 D) $182.63 E) $65.0029. For the loan in the above problem, how much pays off the principal in the second month?
C, 137.46
You have a loan of $12,000 and will repay the loan with monthly payments over 6 years at 6.5% interest compounded monthly. How much pays off the principal in the first month? A) $210.50 B) $201.72 C) $136.72 D) $182.63 E) $65.00 26) For the loan in the above problem, how much pays off the principal in the 16th month?
C, 148.259
17) Suppose you take out a 30 year mortgage for $583,000 with an APR of 4.80%. Payments are made monthly. How much of the second payment is the interest por1on, and how much of the second payment is the principal por1on? A) $1,439.36 in interest, $1,619.44 in principal B) $425.69 in interest, $2,643.31 in principal C) $2,560.14 in interest, $498.66 in principal D) $2,329.09 in interest, $729.71 in principal E) $439.24 in interest, $2,619.56 in principal
D
A new gym just opened in your neighborhood. In order to attract new customers the gym is offering memberships with the opportunity to delay payment for a year. The cost of the membership is $250 annually. If your bank is offering 5% interest, what is the value today of deferring your payment one year? A) $10.20 B) $8.75 C) $13.15 D) $11.90 E) $5.80
D
The owners of Marathon Deli, a publicly traded company, have decided that they want to expand and open up five more locations in the DMV area. To raise money to be able to fund this project, they will issue new shares of stock. In which of the following areas would this transaction occur? A) Secondary Market B) NYSE C) NASDAQ D) Primary Market E) American Stock Exchange (AMEX)
D
To make some extra cash on the side, you consider buying a used car for $2,700 to use as a DoorDash delivery vehicle which will last for 3 years before it will be scrapped for no resale value. Your insurance tells you that you will pay $2,100 per year to insure the car and you estimate that you will earn $3,600 delivering in year 1, $3,750 in year 2, and $3,800 in year 3. Alternatively, you could invest your $2,700 in a market index returning 12% annually. Should you buy the car? What is the NPV of the opportunity? A) Yes; NPV= $2,150.00 B) No; NPV= -$6,208.53 C) No; NPV= -$1,614.68 D) Yes; NPV=$1,164.68 E) Yes; NPV = $1,530.33
D
You are the manager at a manufacturing facility and are looking into a new financing option for a new piece of machinery. The machine costs $45,000. To purchase it, you make a down payment of $9,000 and borrow the remainder of the money at 5.7% EAR compounded monthly, making payments for 3 years. What is your monthly payment? A. $902.22 B. $1,044.89 C. $1,131.44 D. $1,087.97 E. $948.56
D
You buy a security that pays $300 every 6 months for 5 years. Another security with the same risk will also mature in 5 years and pays 12% interest, compounded monthly. What should be the price of the security you just bought? A) $2,316.52 B) $2,633.72 C) $2,453.80 D) $2,192.21 E) $2,536.96
D
You own a tire company as a sole proprietor, and you are considering incorporating as a C-Corp. Last year, your firm's earnings before tax was 26,000,000. The corporate tax rate is 21%, the personal wage tax rate is 35%, and the personal dividend tax rate is 25%. If your firm were a corporation, you would have paid out 100% of last year's earnings as dividends. Would you have benefited with regard to paying taxes if the firm had been organized as a C Corporation? A) Yes, you would have saved $4,225,000 B) No, it would have cost you $4,225,000 C) Yes, you would have saved $3,640,000 D) No, it would have cost you $1,495,000 E) Yes, you would have saved $1,495,000
D
Choose the statement that is FALSE concerning the financial manager in a corporation. A) Financial managers have to make short- and long-term investment decisions B) Financial managers may make decisions that benefit themselves but do not maximize shareholder wealth C) Financial managers are caretakers of stockholders' money D) The goal of financial management should be to maximize shareholder wealth E) Stock-based compensation for financial managers make them more likely to act against the interests of the outside shareholders.
E
James & Co.'s management is under pressure by its board to improve the company's return on equity (ROE) to match that of its peers in the industry. It has sales of $800 million, net income of $40 million, assets of $2 billion, and debt of $1.5 billion. In order to achieve and ROE of 12%, what minimum profit margin should management target, assuming assets, sales, and debt remains constant? A) 5.0% B) 6.5% C) 7.0% D) 6.0% E) 7.5%
E
The League of Heroes is trying to stop Victor Vaughn, a super villain who believes that he will need $1,000,000,000 to build his Doomsday machine that will finally bring him to world domination. He expects his criminal enterprises to bring in $300 million, $130 million, $50 million, and $25 million over the next 4 years.How much will the League of Heros have to prevent him from obtaining in the fifth year to reach his goal of $1 billion in 5 years? Assume Victor is secretly able to reinvest this cash at a 3% rate with the Legion of Supervillains LLC. A) $327.1 million B) $345.7 million C) $219.4 million D) $495.0 million E) $441.5 million
E
You have an investment that pays $100 starting in year 1, and then will grow at 4%/year for the 20 year life of the investment. The interest rate is 10%. What is the value of this investment? What is the value if it pays $100 starting now (year 0)? What is the value if it starts paying the $100 in year 2 (nothing in years 0 and 1)?
Value= 1123.8392 Value if Pay Staring Now= 1236.2231 Start Pay in year 2= 928.79